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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

An analyst compares two emerging market economies hit by the same geopolitical shock. Country A has a large share of foreign non-resident holdings of local-currency government debt, with thin domestic investor base and low reserves. Country B has a deep domestic investor base and high reserves. Which conclusion is best supported?

Country A is more vulnerable. Heavy reliance on foreign holders, a shallow domestic investor base and low reserves leave it exposed to sudden outflows with few buffers, whereas Country B's deep domestic demand and reserves help absorb the shock and limit disorderly market moves.

  1. ACountry A is more vulnerable to abrupt portfolio outflows and market stressCorrect
  2. BCountry B is more vulnerable because high reserves signal weak fundamentals
  3. CBoth are equally vulnerable since the shock is identical
  4. DCountry A is less vulnerable because foreign investors are long-term holders

Explanation

Large foreign holdings, a thin domestic investor base and low reserves make a country exposed to sudden reversals of flows with little buffer. High reserves and domestic investors in Country B absorb outflows. Equal vulnerability ignores differences in structural buffers.

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